The ¥4.3 Trillion Japanese Government Earthquake Liability Cap: A Deep Dive Into The Mechanics Of Japanese Earthquake (Re)Insurance

Tyler Durden's picture

After private Property and Casualty reinsurance companies got whacked on Friday on broad yet unquantified concerns about imminent losses, it is time for a deeper dive into the structure of how prepared Japan is to handle what are sure to be tens of billions in earthquake insurance claims. Using information from the Non-Life Insurance Rating Organization of Japan, we find that there is a clean distinction between the liabilities borne out by the private P&C sector and where reinsurance companies step in to fund losses on residential earthquake losses. A more nuanced breakdown comes from JPMorgan's Siddharth Parameswaran: "In Japan there is coverage provided for earthquake, through two distinct forms: 1) Coverage for losses of residences (governed by "Earthquake Insurance Law," It is covered by the domestic insurance industry and the Japanese Earthquake Reinsurance ("JER") Commission); and 2) Coverage for commercial losses internally insured and externally reinsured without involvement of the government." Of the former two, the first is far more important due to the pervasive losses of real estate in most of the northeastern coastal areas, which according to some estimates will reach in the tens of billions. The three numbers to keep in mind when evaluating potential liabilities are ¥115 billion (or $1.4 billion) which is the threshold for 100% private insurance coverage; next is ¥1.925 trillion ($23 billion), which is the limit on a 50/50 split between losses for private insurers and the JER (or $11.5 billion each), and lastly, ¥5.5 trillion through which 95% of all losses are borne by the government, and 5% by the private industry. In other words the total possible private losses to private P&Cs before reinsurance funding kicks in is about $16.5 billion, while the government stand to lose at most ¥4.3 trillion (or $52 billion). At this point losses are capped, and claims are pro-rated among all claimants. Should total losses surpass about $64 billion in real estate values (at various loss thresholds), claimants will have to settle for pennies on the dollar.

Below is a brief schematic of the general function of the JER from Goldman's Philippa Rogers:


Private insurance companies selling earthquake insurance inside Japan cede 100% of earthquake insurance to Japan earthquake reinsurer (JER). JER then reinsures risk with the government of part of the reinsurance liability.


  • Buildings for residential use
  • Household goods

Risk covered

  • Earthquake, volcanic eruptions, tsunami

Coverage condition

  • Buildings: Total loss/Half loss/Partial loss
  • Household goods: Total loss/Half loss/Partial loss
  • Payment proportion of insurance claim (for the amount insured)
  • Total loss: 100%
  • Half loss: 50%
  • Partial loss: 5%

Attachment proportion

  • 30%-50% of amount insured of fire insurance to which it is attached

Limit of insurable amount

  • Buildings: ¥50 mn
  • Household goods: ¥10 mn
  • Limit of total amount of insurance claim to be paid due to a single earthquake: ¥5.5 trillion
  • Of which covered by the government reinsurance: ¥4.3 trillion
  • Of which covered by the private sector: ¥1.2 trillion

A deeper dive in the JER mechanics comes from JPMorgan's Sid Parameswaran, who was in such a scramble to write this report he copied and pasted verbatim from Wikipedia:

Coverage for losses of residences

  • The government of Japan created the "Japanese Earthquake Reinsurance (JER)" scheme in 1966 which governs insurance coverage for homeowners and storekeepers under the Earthquake Insurance Law. Under this law,  homeowners can buy earthquake insurance from an insurance company as an optional rider to a fire insurance policy to cover both property damage to their dwelling as well as contents. The perils covered include fire, destruction, burying and washing-away caused by earthquake, volcanic eruption or tidal wave resulting there from (tsunami). The amount insured for earthquakes is limited to 30-50% of the amount insured under the comprehensive insurance policy, subject to a further limit of JPY50m for buildings and JPY10m for contents (source: Non-Life Insurance Rating Organization of Japan). There is a further scaledown based on the extent of the loss. A "total loss" will trigger a 100% payout of the insured amount for catastrophe, but it will be scaled back to 50% for a "half loss" and 5% for a "partial loss." As such, it appears that a majority of property losses are likely to fall on individuals themselves unless they suffer total loss.
  • Insurers enrolled in the JER scheme who have to pay earthquake claims to homeowners share the risk among themselves and also the government, through the JER.

A visual summary of the flow of funds in the JER:

Next, JPM proves that using a 114 USDJPY exchange rate is perfectly normaly when copying and pasting from Wikipedia:

The JER (backstopped by the government) pays a much larger proportion of the claims if a single earthquake causes aggregate damage of over about 1 trillion yen (about US $8.75 billion) (source: Wikipedia). The maximum payout in a single year to all JER insurance claim filers is 5.5 trillion yen; if claims exceed this amount, then the claims are pro-rated among all claimants.

This insurance is NOT reinsured with overseas markets. It still could have some impact on global capacity. As a point of reference, Japan accounts for about 6% of world P&C insurance premiums (Net Earned Premium JPY6,971,058m, of which Foreign insurers have 5.6%, according to the General Insurance Association of Japan). At the end of March 2010, 46.5% of dwelling risk policies had earthquake insurance. As such, our initial thoughts are that the impact on global capital is likely to be limited.

Visually, this looks as follows:

Commercial losses can also be claimed, although here the private industry is entirely on its own:

Unlike householder’s coverage, commercial earthquake coverage is provided by private insurers and not by the government or a government-run fund. Earthquake coverage is an extension of the main fire policy which is available for an additional premium. However, due to very restrictive terms and conditions and the price associated with coverage many policyholders do not purchase this coverage – take-up levels have been described as “modest” in an Aon Benfield report (“When the Earth Moves: Mega-earthquakes to come?”). Further to this, coverage also is on a first loss basis rather than a full value basis, meaning the sum insured covered by the policy is less (potentially as little as 15%) of the full value of the property at risk.

In an extreme loss scenario, the combination of the modest take-up of earthquake insurance extensions and limited sum insured values, this restricts the loss to an insurance company.

JPM's conclusions appear rather spot on:

Implications for Global Insurance Industry

It appears to us that all the losses in Japan on residential houses are likely to remain within the country, given the nature of their coverage and the lack of use of external reinsurance. Japanese premiums account for about 6% of the insurance market as well, so the spillover impact on global insurance markets and capital from won't be inconsequential but will likely be limited. Also, given the limited coverage actually provided to households, it appears individuals  (even those with insurance) will bare a substantial proportion of the costs.

In terms of commercial coverage, it appears from our exploration of industry publications that coverage is limited. As such, we conclude that two effects are likely to be seen: (a) some losses will hit balance sheets of global reinsurance companies, and (b) the losses, in our view, are unlikely to be large enough to cause an upturn in the premium rate cycle.

Broader Market Implications

There is likely to be liquidation of some funds by the JER and insurers in Japan to fund the earthquake. They probably would have invested some of their funds outside of Japan to avoid the negative correlation risk between their liabilities (Japan Earthquake) and their assets.

There also may be a further issuance of bonds by the Japanese government to fund their liabilities.

Companies in Japan and individuals in Japan may be bearing a significant proportion of the financial costs of the events (not to mention the human costs).

For what it's worth our take is that while international reinsurers, especially those from Europe, got hit badly on Friday, the market will realize that their liability is most in the commercial side. On the other hand, with potential losses of up to ¥4.3 trillion, the Japanese government itself will likely be forced to scramble to provide funding should Japan have pulled an "America" and left the reserve for the JER dangerously underfunded (obviously, should losses surpass this limit, the Japanese government will be facing many unhappy citizens, who suddenly realize they will face a discount on their insurance proceeds). That said, for Japan, a ¥4.3 trillion number is absolutely massive and should it have to pay out some or all of this amount, it will be left with no liability reserve for any future aftershock escalations. Unfortunately trying to glean some additional data on this critical variable proves impossible. From an overview of the "Earthquake Insurance System in Japan"

Liability Reserves

The frequency of occurrence of earthquake disasters is low, and besides, although they sometimes cause massive losses, it is impossible to predict when they will occur. Therefore, as for insurance premiums paid by policyholders, both insurance companies and the Government are obligated by the law to accumulate the total amount of such, excluding the portion of necessary expenses for contracts, as liability reserves in preparation for future earthquake disasters.

Additionally, it is obligated that all the investment profits from the accumulated liability reserves also be accumulated as liability reserves. Respective insurance companies are respectively accumulating the insurance premiums distributed in accordance with the respective burden of share as liability reserves, and are also accumulating all the investment profits from the accumulated liability reserves as liability reserves. The J.E.R. is managing and performing investment of these liability reserves in lump sum so as to pay insurance claims quickly to the victims of earthquake disasters. Investment of these liability reserves is limited to savings, national bonds, public bonds and corporate bonds, etc., since liquidity and safety of investment are required at the time of earthquake disasters.

The Government is accumulating the reinsurance premiums obtained and all the investment profits from the liability reserves as liability reserves. These liability reserves are accumulated separately from general accounting, under the Law concerning Special Accounts.

Alas, in an environment in which the world's biggest bank copies and pastes from Wikipedia, it is clear that few if any have any idea how this tragedy will play out, suffice to say that it will require a massive issuance of new paper at both the public and private sectors, most certainly accompanied by further rounds of quantitative easing on all sides of the Pacific (and Atlantic). Unfortunately, we expect sovereign paper volatility, especially that of Japan to add to the already chaotic picture come Monday when the market evaluates the implications of what has just transpired.

Full overview of the Japanese Earthquake Insurance System from the NIRO.


Comment viewing options

Select your preferred way to display the comments and click "Save settings" to activate your changes.
ZeroPower's picture

Yup, liquidations they will do! But i propose to you the insurers must be fairly well hedged as well. And plus, theyve been collecting premiums what, over 20 years now?


At least the gov is stepping in: BoJ to provide cash injection into money markets - supplying 2trillion yen (US$24.4billion) a day, for two consecutive days 

Michael's picture

The only thing I want to know is; Will Japan sell it's US treasury holdings to pay for the cleanup and how much of it?

ZeroPower's picture

Naw, they shouldn't do anything to offend the US gov (i.e military) in their current help efforts.

Id say a JPY version of QE3. Will be very interesting to see JPY trade (especially against EUR and USD) on Sunday night after initial reaction to the upside which, imo, won't last.

Michael's picture

It would be a great act of generosity on the part of the US to allow without prejudice,  Japan to use its savings for this most spectacular of rainy days. 

Paul Krugman's picture

Hey Tyler Europe just approved (at 1:30 AM) a new rescue package. Any opinion. Looks like more money printing.

NewThor's picture

I'm coming out with a global economy saving new invention!

The Ben 'MABUS' Bernanke home printing press!

Short on your Hummer3 payment? Print up a few thousand!

Having trouble getting that Hooters waitress to flirt with you? Print up a couple of hundred!

Are you starving? Print up some $20s and see if you can eat 10,000 calories of Taco Bell in

one sitting!

Do you need a couple of Extra Bucks for a new STAR WARS shoot down arrows with arrows

system or do you want to build a 100 foot wall between America and Mexico? 


If you act now we'll throw in the new Trillion dollar bill plate for free!

'In God we Trust and on the printing press we depend!'

I just copyrighted this idea, so don't steal it jerks!


Oh regional Indian's picture

And this is just the start. The insurance business is such the basis for this scam we are in, financially, globally (any wonder AIG shook the base in 08?), that it is ironical and fitting that this is the undustry (yes, undustury) that will bring the house down.

Warm up phase on now.



Atomizer's picture

The echelon is biting down on the foot soldiers to produce. Certain alphabet soup agencies and insurers are tits up.

Creditfixing is not available at moment.


Rhone_Ranger's picture

Earthquake coverage provided courtesy of AIG.

RockyRacoon's picture

The big news and tragic stories will be how insurance companies are skipping out on payments and shilling the payouts they do make.   Don't think Big Insurance is actually going to do the right thing here.   (Remember New Orleans for the microcosmic view.)

Yen Cross's picture

Just scrolling Rockie.  I like your posts. Have a good weekend!

Orly's picture

I imagine Buffett will make a king's ransom here, some way, some how.

davepowers's picture

so that means if the residential side losses exceed $64 bn, then the insureds get only a prorated recovery of their damages? right?


lolmao500's picture

Yep. You get screwed...


And what about LIFE INSURANCE? Do people's deaths insurance come in this limit or it's another fund?

Seasmoke's picture

they will blame it on the water damage and get out of paying


insurance is great to have until you need the fine print !

Atomizer's picture

Tyler, have a question. Considering oil has been considered a financial instrument within the halls of wall street derivatives market, how will the new Japan Carry Trade play out? Please keep your answer geopolitical & not financial. I can piece together my rabbit hole outcome.

Thank you.

spanish inquisition's picture

Good thing Ben has been able to run the printers all weekend long without market interference.

Josh Randall's picture

Cue North Korean Dictator to rear his head with off the wall behavior to draw attention to himself - wait for it -

AN0NYM0US's picture

The visual summary of the flow of funds in the JER graphic that you posted above bears a striking resemblance to the graphic depicting the BWR reactor at Fuku that you posted in another thread earlier

falak pema's picture

Wait till Japan starts selling its USD denominated T-Notes/bonds. To finance the up-coming rehab program. What will that do to the dollar if they unload all those T notes pronto on the market....?

falak pema's picture

As you know the Koreans have had a run on their banks. When the USD starts being hit by Yen repumping by Japanese govt. it will send shock ripples through the whole SE asian market. The Yuan will be under pressure as what the yen does to USD exchange rates in not indifferent to China, due to yuan pegging. Uncertain times in the money markets AND the commodity markets, as the oil price goes either way as of next week, under Japan's initial refinery stall and then subsequent nuclear short fall. (I don't know to what extent the nuclear immediate dip can stimulate oil fed electrical generation demand in Japan).

Rogerwilco's picture

Tens of billions? Multiply by ten, and then double or triple that number. This is a tough break for the Japanese people, but they will pull together and overcome the hardships.

Quinvarius's picture

In other words, sell the retirement fund to rent an apartment somewhere now that you home is gone.  At the same time, the government prints more money or dumps US treasuries.

r101958's picture

Sounds an awful lot like something we should have done with TBTF banks.

max2205's picture

Homeowners will be hoping for fallout damage payments

thx111's picture

Japanese life insurance companies holds a lot of US treasuries.  I wonder if those Japanese insurance companies (and Japanese gov. )have to sell some US treasuries to fund their liabilities. 

virgilcaine's picture

That explains it.. an Enron style insurance policy.. No wonder it blew .

Atomizer's picture

Enron #54

The accounting firm of Arthur Andersen, which employs all types of rogues, was indicted for its role in the Enron scandal.

Bring out the old and cross your fingers it works this time around

PriceWaterhouseCoopers Ad



We serve your needs to bury the bones

strannick's picture

Hope Buffet has some of these policies

KickIce's picture

Average Joe gets the shaft once again.

Individual policy and collective liability with a limit.

PulauHantu29's picture

You can forget all contract law, and all Japanese statues. Look how well the "cap" worked for BP.

The Japanese government will pay 100% + for damages and The Bernank will kick in a few Trillion imho.

The Alarmist's picture

Correctamundo ... politics just doesn't work that way, and you can count on "all bets being off" as the losses are so widespread that the only way out is to socialise them across the whole nation ... unless, of course, the Fed steps up to underwrite them (given their history, it could be that all bets are not off).

lolmaster's picture

In other words ... QE just went nuclear.

Milstar's picture

No disrespect Tyler but Jefferies said it was only 10 billion in damages.  I don't think they have any reason to lie about that well researched number.

robertocarlos's picture

When we get hit by a big asteroid I will expect a cheque.

The Alarmist's picture

You will get that check, but first we will need to pump more money into the banks again so we can write it and you can cash it.